Enforcement actions often call for banks to increase capital, but a recent order for Hanmi Financial Corp. shows regulators are getting pickier.
They want more common equity.
The $3.5-billion asset Hanmi said Thursday that the California Department of Financial Institutions has told its bank unit to increase its ratio of tangible shareholders' equity to tangible assets. This is not one of the three standard regulatory capital ratios, and several observers said they have never seen it specified in an order before.
It was the latest signal from regulators, who previously had paid attention only to the usual three ratios, of the growing importance of common equity as a capital component.
California's use of the words "shareholders' equity" sends a subtle message: regulators want genuine capital, the kind that can absorb losses and is not inflated by amorphous assets like goodwill or deferred tax assets.
"They are saying 'we want the real deal here,'" said Eric Luse, a partner at the law firm Luse Gorman Pomerenk & Schick PC. "This reflects the current trend that, at the end of the day, tangible common equity is the only real cushion for banks, and regulators are observing everything under that as questionable."
The stress tests of the 19 largest banking companies suggested regulators want common equity to make up two-thirds of overall Tier 1 capital. Common equity was an element of the policy statement released by the Federal Deposit Insurance Corp. on private equity's role in banks. Regulators also have weighed a company's tangible common equity when approving applications to repay investments made under the Treasury Department's Troubled Asset Relief Program.
Hanmi did not return calls by press time. A spokeswoman from the California regulator said by email that regulators have always used the tangible shareholders' equity to total tangible assets ratio as a measurement of capital adequacy.
Richard Spillenkothen, the Federal Reserve's former director of supervision who is now a partner at the Deloitte Center for Banking Solutions, said the California order's focus on the tangible demonstrates "a more conservative way of looking at the true strength of the capital."
Spillenkothen said he is not familiar with Hanmi, but he expects more banks to be held to similar requirements in future enforcement actions.
Chip MacDonald, a partner in the law firm Jones Day, said that the term "tangible shareholders' equity" could technically include noncumulative, perpetual preferred stock, but any increase in shareholder equity would come through common equity given the current market conditions.
Under the order, Hanmi Bank's ratio of tangible shareholder's equity to tangible assets must be at least 7% by Dec. 31 and 9.5% by the end of next year.
At Sept. 30, the ratio was 7.57%. But Julianna Balicka, an analyst with KBW Inc.'s Keefe, Bruyette & Woods Inc., said that with credit trends continuing to worsen, that figure is likely to slip. "Have their problems peaked? They've been working really hard, but God knows," she said.
The California order also requires the bank to increase its equity capital by no less than $100 million by July 31 of next year. Hanmi separately entered into a written agreement with the Fed that requires it to submit a capital plan within 60 days.
Credit losses have eroded the company's capital. Its provision for loan losses more than doubled from the second quarter, totaling $49.5 million at Sept. 30. The provision, along with a $38.2 million valuation allowance on Hanmi's deferred tax assets, drove a third quarter loss of $59.7 million.
During a conference call with investors Thursday, Jay S. Yoo, Hanmi's president and chief executive, said he expects improvement in the fourth quarter.
"There are many challenges ahead of us, particularly in the credit quality of our loan portfolio," Yoo said. "I believe that we will see improvements in asset quality and in our capital ratios in the fourth quarter and 2010."
On Sept. 30, Hanmi Bank met all of the traditional guidelines for well capitalized, but with a leverage ratio of 7.05%, it was not in compliance with a memorandum of understanding that it entered into earlier this year with the Fed and the California agency that required that ratio to be above 8%.
The company has received $6.9 million of an $11 million investment from Leading Investment and Securities Corp. Ltd., a Korean broker-dealer. The remaining $4.1 million is awaiting regulatory approval and was slated to close Sept. 30, but was postponed to Nov. 30. Yoo said during the call that it will likely be pushed back further because of regulatory delays.
Hanmi also said in September that it had a nonbinding agreement with IWL Partners LLC, another Korean company, for an $89 million investment. Yoo said that the investors have completed due diligence, but again regulatory approval has held things up.
Walter J. Mix III, a managing director at LECG Global Financial Services in Los Angeles and a former commissioner of the California Department of Financial Institutions, called the order unusual, but said it was an indication of how regulators view the condition of Hanmi.
"The language typically doesn't get that specific," he said. "I would say that it is very telling of the challenges this bank faces. Regulators want the purest form of capital in that institution."